This is (more or less) the text I used for the discussion at last week’s Compass meeting.
Other views are available …
I am a bit nervous about posting this piece as a) it’s about economics rather than politics and b) I’m an amateur, so I may be misunderstanding bits, but I think I have the general gist. Nevertheless, I think its importance is essentially political, and helps to put policy options in a new perspective. With luck, it will at least generate a discussion.
I’d like to start with a quotation. This is from a rich man who opines:
There is no money at all, except for that earned in the private sector. Public sector workers may pay tax, but that merely circulates money between departments; tax paid by NHS workers comes and goes from the consolidated fund with some administrative expense in between.
My initial reaction on reading this was “that’s gobbledygook”, but I noticed later as I was thinking through some aspects of my talk that it did raise an issue, and I could see how our friend, the member for North East Somerset, had got so confused. We shall return to it in a bit. I would though just note that it’s still gobbledygook, and, if the gentleman who may be our next prime minister is that economically illiterate, we should be concerned.
Anyway, let’s see what we know about the way the economy works. We pay our taxes and the government spends them. If the government spends more than it takes in tax, it has 2 choices – either to raise taxes or, cut expenditure (no prizes for guessing which it will choose). It can also borrow the money short term (but has to pay it back with interest, so not a popular option) or long term (which will add to the National Debt and put our children/grandchildren in Carey Street (if that still exists)). The Coalition chose austerity, as did its successor and the government has now balanced the books (at least on current expenditure). So the future is bright, then, according to Mr.Hammond, with his newly obtained “fiscal space”.
But there are some troubling aspects to this assumption. Consider, as a start, how we pay our taxes – where does our money come from to give to the state in the first place? Some from the state, so that can’t work; some from employers, who get it from where? And so on back to some mysterious source. Hence Mr Rees-Mogg’s problem. He knows that this works with private money, but public money is left in a vicious circle. Presumably he would prefer all money to be from the private sector, but then what would be the point of taxation? So how can the government work while waiting for us to summon up tax money from who knows where? Also, suppose, God forbid, we had a new Falkland-type crisis. The government needs a lot of money, and fast. It can’t wait for its usual, or even extra, tax revenue to come in, what does it do? Not it may have some contingency fund, but frankly that sounds a risky bet, so how does it pay for emergencies? Answer: the system doesn’t actually work like that.
To get a better feel for the process, we need to be clear what money is. For now, I would ask you to accept my definition (not just mine) that money is a promise to pay (as on banknotes). Therefore money depends on debt. Unfortunately, that sounds alarming, but remember debt makes the world go round. If you take out a bank loan, what happens? A new account is set up. When you pay back the loan (plus interest, which is just the bank’s fee), what happens? The account is closed. Where does the money go? Effectively nowhere – it is destroyed.
Think of this on a large scale – if all debts were paid off, what would be left? Nothing. There would be no money. (Steve Keen has observed that if there were no bankruptcies, the economy would collapse). Therefore, the debts are the money; and spending is merely exchanging assets and liabilities. And one person’s debt is another person’s asset. Keynes’s paradox of thrift states that saving is good as long as not everyone is doing it. Likewise, debt is bad unless you are the creditor.
So why is this important at a national level? Because the government uses money like we do. But with one difference. Mrs Thatcher famously said “There is no such thing as public money; there is only taxpayers’ money”. Actually, it’s more the other way round. Governments are not like households, simply because households don’t have their own currency. It has been said that “Anyone can print their own money – it’s getting it accepted that’s the difficult bit.” As the sole issuer of currency, the government has the ability to spend purely according to the usefulness of the transaction, not the state of its savings, unlike the rest of us.
When George Osborne used the expression “maxing out the government’s credit card”, he was unwittingly on to something. The government does have a credit card with the banks, only it has two special features: it doesn’t have a maximum limit, and it doesn’t have to pay the money back. It can spend whatever it likes. The implications of this we will come back to later, but for now let’s just note that the government’s money is newly created money (the magic money tree is real). Banks create money when they make a loan, and destroy it when the loan is paid, as we noted above. They do the same for the government under licence (the Bank of England should do it, but EU regulations prevent it, stupidly), and this is effectively a gift, not a loan, and the government, to use the common term, “spends it into the economy”.
So, if the economy doesn’t work by “tax-and-spend” how does it function? You guessed. “Spend-and-tax”. The government creates what it needs to spend, spends it and then retrieves the money in tax. More or less. Actually, as I intimated earlier, balancing the books is not the aim of the exercise. Taxation exists for two main reasons (hint: obtaining revenue is not one of them). These are to control the money supply (or control inflation, if you will; it’s much the same thing), and to validate the currency by making taxes only payable in that currency (stop saving your bitcoin now). There are other reasons, of course, but, as Stephanie Kelton says:
You don’t tax the rich because you need their money in order to feed a hungry kid or fix a crumbling bridge. You tax the rich because they are too damn rich and extreme concentrations of wealth especially, but also income, are bad for the functioning of the economy, are bad for democracy. That’s the rationale for taxing the rich. Not because we can’t do other things unless we get money from them to pay for it.
The government may raise or lower taxes to affect the level of inflation, but it has little bearing on the amount it is spending. I would note that in my view raising the income tax threshold is generally a bad policy as it removes the connection between payer and government – though you could reduce the rate, of course.
But, you will argue, if the government can spend what it likes without let or hindrance, won’t this lead to inflation anyway, like Weimar or Zimbabwe or Venezuela? Apart from observing that 3 examples of hyperinflation caused by entirely different circumstances do not make a good argument, the point is that it depends on what the government is spending on. Inflation is always a danger (although less so now than ever, for reasons not fully understood), but it won’t happen until there are no resources for the government to buy. Reach full employment and a fully-functioning infrastructure and welfare service, and more new money would cause inflation (too much money chasing too few resources), but that’s not exactly likely to happen, and, if it did, the government would just stop spending, having nothing more to buy.
Chancellors love to talk about the cost of things, but they never talk about the return. Spending x billion on a new road, hospital, school whatever has a payback, otherwise why do it? It will bring employment, better education, better health, more spending, more tax returns, more trade and so on – the multiplier, to use the technical term, is usually above 1 i.e. you get more back than you spend in the long run. So when the IFS beancounters say at Budget time “the Chancellor can’t afford to do that” they are talking poppycock.
Where does this leave the deficit? Well, essentially, it doesn’t matter. The deficit is what it is, and does not require “fixing”. Most sensible governments will run a deficit, as this leaves the private sector in profit (see above about debt…I’ll leave sectoral balancing for another time…). But it’s generally impossible to manage a balanced budget, and chancellors are kidding in claiming to be able to. Cutting government expenditure may reduce a deficit, but the concomitant losses elsewhere in the economy will offset the effect, as we know from what happened with austerity. Running a surplus is not a good idea, as it takes away private sector savings. A deficit on the current account indicates that things are going as they should …
To return to our taxpaying. To sum up, the government spends the money into the economy, it travels round and is clawed back in tax so that the government can keep the economy on an even keel. Like our bank loan, the money is created and then destroyed through taxation. Sometimes, radical economists will say “Your taxes don’t pay for anything.” This is technically true, but a bit misleading, as only by adjusting tax levels can the government direct the economy. One of the consequences of all this is that fiddling with tax systems is largely pointless – if the aim is simply to stop private savings getting too large (which it might be), it doesn’t matter too much how you get there; hypothecated taxes thereby are clearly a nonsense, unless you just want to make a political point (actually, you can’t say “we’ll spend an extra 1p per person on the NHS”, because there is no way of making it happen).
So what about borrowing? Why would a government borrow to pay for something it can pay for anyway? Candidly, they’re being kind. Financial institutions love government bonds and gilts because they are safe. The government likes to keep them happy and, with low interest rates, they can afford to be generous. Servicing debt is not expensive, and, if inflation took hold, the value of the debt would decrease anyway. What’s not to like?
At the other end of the scale is the National Debt (or National Savings as some of us would prefer to designate it). This is just a record of all the transactions that the government has been involved in, rather than a total bill to be paid (with quantitative easing, half a billion pounds of debt is owed to the Bank of England, so that hardly counts, for example). To put it another way, the National Debt is simply a record of the money the government has spent that has not yet been reclaimed in tax. Doesn’t sound so bad then, does it? In any case, who owns the debt? The markets. Who is the biggest investor in the markets? Pension funds. Who invests in pension funds? You and me. Who would like the National Debt to be paid off so as to receive a nice cheque? You and me. No, our kids won’t have to pay it, just as we haven’t, and most of it will never be paid, as it will tend to shrivel away. Osborne’s paying off of a 100 year old debt was mere showboating. Don’t forget – repayment of debt destroys money.
In sum, why does it matter that we don’t understand how the system works? It matters because it is hugely political. We know that austerity was a bad decision; knowing that there was a perfectly good alternative that would have led to growth and no loss of employment, health and wellbeing, makes it worse. When a political party is challenged “How will you pay for it?” they get defensive and say ”We’ll save on this other stuff”. They shouldn’t. They should say either “It will pay for itself” or “It will have no real cost” or, as Richard Murphy bluntly puts it “We aren’t going to.”
Modern Monetary Theory (which is the cumbersome name this explanation is known by) is merely an attempt to demonstrate how things work – it’s not a radical new departure, or even necessarily left-wing. But it makes arguments about what we can or can’t afford as a nation much clearer, and reveals the mainstream neoliberal argument for what it is – an attempt (very successfully) to deprive the population in general of its entitlement to work, health and wellbeing by making it appear a privilege not a right.
I’d like to finish with a quote from a politician who is starting to get it:
I have not been worried about the state deficit for sometime, ever since Mr Brown found out that the UK state can literally print money to pay its bills … The state can always raise enough money to pay the domestic bills backed by the huge powers to tax, and as we have just seen when credit expansion and inflation are low it can also use liquidity created by the monetary authorities.
Who? John Redwood. We’re getting there.
*Because it doesn’t know